Oculus Innovative Sciences IPO Analysis: Six Month Review

Oculus Innovative Sciences, Inc. (NASDAQ:OCLS) is a recent IPO that is developing a product for the treatment of chronic wounds, Microcyn, which they call “stable super-oxidized water.”

· The active chemicals in Microcyn are hypochlorous acid and sodium hypochlorite, commonly available disinfectants found in household bleach, swimming pools and tap water.

· It appears that a solution chemically indistinguishable from Microcyn could be made by diluting bleach in normal saline solution and adjusting the pH to 7.5.

· The complete absence of anything proprietary here is underscored by the multiple products currently on the market that are highly similar to Microcyn.

· The magnitude of the commercial opportunity can be assessed by looking at a licensing deal Kinetic Concepts recently inked for a competing compound, in which they paid $200,000 up-front and committed to $1.25 million in milestones.

· Although Microcyn is currently approved under a 510(k) application, the company’s commercial strategy is to develop the solution as a drug by successfully executing a regulatory-quality clinical trial program – given the extremely poor quality of the clinical data generated to date for Microcyn, one must view the strategy as high risk.

· As a healthcare investor, I frankly find it offensive that a company developing a treatment not meaningfully different from diluted bleach can successfully execute an IPO and have a market cap north of $100 million.

Details:

Oculus is developing a product called Microcyn or Dermacyn for diabetic foot infections. Microcyn is a “stable super-oxidized water” product from the company’s Microcyn platform, “a non-irritating solution containing oxychlorine compounds that is designed to treat a wide range of pathogens, including antibiotic-resistant strains of bacteria, as well as viruses, fungi and spores.” Sound impressively high-tech – it would only be better if it were nanoparticle super-oxidized water.

Microcyn/Dermacyn is actually already an FDA-approved product, having received 510(k) clearance in 2005 and 2006 for moistening/lubricating dressings for acute and chronic traumatic wounds, for moistening/debridment of acute and chronic dermal lesions, and for moistening dressings for and cleaning of minor cuts. It also received the CE Mark for similar indications in Europe in 2004 and was approved in Canada, Mexico and India. According to documents on the FDA web site, “the product is similar in function and intended use to Saljet Single Dose Sterile Saline Topical Solution manufactured by Winchester Laboratories . . . non-clinical testing was conducted to confirm the safe and effective performance of Dermacyn™ Wound Care Dressing as co! mpared to 0.9% sterile saline.” FDA documents also reveal, most tellingly, that “the Dermacyn™ Wound Care Dressing is substantially equivalent to the currently cleared and marketed Saljet Single Dose Sterile Saline Topical Solution, 0.9% w/v Sodium Chloride.” So the 510(k) clearance views Dermacyn as no more than saline. That having been said, it does contain reactive chlorine species – this is why it is called “super-oxidized water” – and reactive chlorine species are well known to offer an anti-microbial effect (much more on this below).

Of note, there have been multiple 510(k) clearances for products very similar to Microcyn/Dermacyn. The company PuriCore received 501(k) clearance to market Vashe, a hypochlorous acid solution product that appears to be virtually identical to Dermacyn. PuriCore also sells a system to generate a similar antiseptic solution in the office (Sterilox). One can buy over the internet ExSept, another 510(k)-cleared topical disinfectant containing sodium hypochlorite in normal saline. And finally but most ominously for Oculus, wound care behemoth Kinetic Concepts entered the fray with a June 2007 with a licensing deal with NovaBay Pharmaceutic! als (who has filed an S-1 and is apparently thinking IPO) for NeutroPhase, “a stable, rapid-acting solution containing hypochlorous acid, which is known to kill a broad range of bacteria in seconds.” If deal size is a proxy for the market size of the product, then what can one make of the $200,000 up-front payment and $1.25 million in milestone payments that KCI paid for NeutroPhase? These numbers are truly a pittance in the scheme of drug development deals.

Given that the product is already approved and not generating much revenue or interest, what is the company’s plan for turning this into a commercially meaningful product? Oculus plans to run regulatory-quality clinical trials and get the product approved as a drug, with a labeled indication for treatment of chronic wounds, and they believe they will be able to charge a substantially higher price. They are running a phase II study, looking to enroll 60 patients with mildly infected diabetic foot ulcers, who will be treated for 10 days then followed for 14 days. According to the CEO’s comments during a June 7, 2007 conference call, “this study is a three-arm trial that will evaluate the safet! y and preliminary efficacy of Dermacyn as a monotherapy; meaning, just using Microcyn technology for treatment of the infection, as well as in combination with systemic oral antibiotics.” They expect to present the results at ICAAC, an infectious disease meeting, in September 2007. When asked about launching the product under the current 501(k) approvals, the CEO said the following:

So the product is approved by FDA as a medical device in the United States for cleaning, debriding and moistening wounds. We do not have antimicrobial label claim. So therefore what we do not intend to commercialize the product as a medical device, but we do is we make it available passively to the hospitals and doctors to get feedback from them on how they like the product, what benefits do they see, what challenges do they see, and actually we are getting significant positive response from physicians and hospitals about the use of product. The reason we don’t want to commercialize as a device in the US is that as a device we can sell this product for example for $20 per bottle in the US, but if we can wait and get our NDA approved the same product can be sold for $70 or $100 or even more per bottle. Now at $20 we alr! eady have pharmaceutical margin, but so you can see the huge financial upside for us. Secondarily, if you launch it as a device in the US then as a lot of you guys know you can always bring your price down but you’re going to have a hard time commercializing a product at 20 and then go back and say, “Hey, by the way the same product now you have to pay $100.”

Before diving further into the product and the data supporting Microcyn/Dermacyn to figure out if it could possibly be sold for $70-$100 per bottle, there are many details in the S-1 that suggest something amiss with this company. Here are some tidbits:

· “We have sponsored the majority of physicians performing physician clinical studies of Microcyn and in some cases, the physicians who performed these studies also hold equity in our company.” My read – the doctors running the trial are conflicted at best, on the take at worst.

· “The physician clinical studies were performed in the United States, Mexico and Italy, and used various endpoints, methods and controls. These studies were not intended to be rigorously designed or controlled clinical trials and, as such, did not have all of the controls required for clinical trials used to support an NDA submission to the FDA in that they did not include blinding, randomization, predefined clinical endpoints, use of placebo and active control groups or U.S. good clinical practice requirements.” My read – the clinical trials did n! ot adhere to any known standards of design, execution, data collection, or analysis.

· “On June 16, 2005, we entered into a series of agreements with Quimica Pasteur, or QP, a Mexico-based distributor of pharmaceutical products to hospitals and health care entities owned or operated by the Mexican Ministry of Health, or MOH. These agreements provided, among other things, for QP to act as our exclusive distributor of Microcyn to the MOH for a period of three years. We were granted an option to acquire all except a minority share of the equity of QP directly from its principals. In addition, two of our employees were appointed as officers of QP, which resulted in the establishment of financial control ! of QP by our company under applicable accounting literature. As a result of our agreements, we were required to consolidate QP’s operations with our financial results. In connection with our audit of QP’s financial statements in late 2005, we were made aware of a number of facts that suggested that QP or its principals may have engaged in some form of tax avoidance practice prior to the execution of the agreements between our company and QP. We did not discover these facts prior to our execution of these agreements or for several months thereafter. Our prior independent auditors informed us that we did not have effective anti-fraud programs designed to detect the type of activities in which QP’s principals engaged or the personnel to effectively evaluate and determine the appropriate accounting for non-routine or complex accounting transactions.” My read – they bought a company run by the Mexican gov! ernment that was engaging in tax fraud, but didn’t have a clue.

· “Our former independent registered public accounting firm has notified us of a number of reportable events constituting a material weakness over financial reporting which, if not successfully remedied, may among other things, impact our ability to develop reliable financial statements and comply with our reporting obligations as a public company.” My read – they have no idea what is happening inside the company financials.

· “Although we have filed U.S. and foreign patent applications related to our Microcyn based products, the manufacturing technology for making the products, and their uses, only one patent has been issued from these applications to date. . . . one of our former contract partners, Nofil Corporation, whom we relied upon to manufacture our proprietary machines had access to our proprietary information and we believe undertook the development and manufacture of the machines to be sold to third parties in violation of our agreement with such company. We have brought a claim against Nofil Corporation in the U.S. District C! ourt for the Northern District of California. We believe that a former officer of our Mexico subsidiary collaborated in these acts, misappropriated our trade secrets, and is currently selling products in Mexico that are competitive with our products.” My read – their proprietary manufacturing process is not so proprietary.

· In 2004, the company also achieved EPA approval of the same solution under the brand name Cidalcyn. However, “in more recent tests conducted by the EPA, Cidalcyn did not meet efficacy standards when tested against three specified pathogens . . . when used according to label directions. These new results prevent us from marketing Cidalcyn as a hospital grade disinfectant.” In addition, “in August 2006, we received a ‘show cause’ letter from the EPA stating that it was prepared to file a civil administrative complaint ag! ainst us for violation of federal pesticide legislation in connection with the sale or distribution of a pesticide that did not meet the label’s efficacy claims.” My read – their claims about the efficacy of Dermacyn/Microcyn may not hold up under government testing.

· This piece did not make it into the S-1, but is of interest anyway – Brookstreet Securities, one of the three firms on the cover of the offering document and the second largest shareholder with 812,000 shares, filed for bankruptcy in June as its ill-placed bets on collateralized mortgage obligations went awry. My read – six days trading volume needs to be dumped on the market.

All that stuff is good for laughs, but now let’s look into the “technology” behind Microcyn. So what is this stuff, anyhow?

We believe Microcyn’s ability to treat and help prevent infection and its sterilant properties are based on its uniquely engineered chemistry. As a result of our proprietary manufacturing process, Microcyn contains a wide array of reactive chemicals that, among other things, interact and inactivate surface proteins on microorganisms and viruses. The function of these proteins are varied and play significant roles in cell communication, nutrient and waste transport and other required functions for cell viability. Once Microcyn surrounds single cell microorganisms, it damages these proteins, causing cell membrane rupture, leading to cell death. This destruction of the cell appears to occur through a fundamentally different process than that which occurs as a result of contact with a bleach-based solution because experime! nts have demonstrated that Microcyn kills bleach-resistant bacteria. However, the solution remains non-irritating and human tissues because human cells are interlocked and prevent Microcyn from targeting and surrounding single cells topically on the body.

Now, for the facts. According to the EPA and the Material Safety Data Sheets, the active ingredients of Microcyn are sodium hypochlorite 0.0036% (37.5 parts per million or PPM) and hypochlorous acid 0.0025% (25 PPM). To understand what these chemicals are, we have to do a bit of chemistry (bear with me). These details are readily available on the web; for example Wikipedia has a nice piece on hypochlorous acid (http://en.wikipedia.org/wiki/Hypochlorous_acid).

Chlorine gas dissolves in water to form hypochlorous acid (HOCl) and hydrochloric acid (HCl). Hypochlorous acid is a very potent anti-microbial agent and antiseptic. Hypochlorous acid then can dissociate to H+ and OCl-. OCl- is the hypochlorite ion, which also has antiseptic properties but is significantly less potent than HOCl. Thus, a hypochlorous acid solution will be a more potent antiseptic at a pH lower than 7 (acidic), when most of the chorine is present in the form of hypochlorous acid, than at a higher pH (although at very low pH the solution becomes unstable and releases toxic chlorine gas, an undesirable event! ) . There is yet another player in this system, which is sodium hypochlorite (NaOCl), the sodium salt of hypochlorous acid. In solution, sodium hypochlorite dissociates into Na+ and the hypochlorite ion, therefore it too has antiseptic properties. And of course, if one took a sodium hypochlorite solution and lowered the pH (for instance by adding hydrochloric acid, HCl), one would increase the concentration of hypochlorous acid, thus increasing the antimicrobial potency of the solution.

By mixing water, salt (NaCl), and hypochlorous acid and/or sodium hypochlorite, and adjusting the pH, it is possible to create a wide variety of solutions with antiseptic activity. Indeed, the antiseptic characteristics of chlorine-based solutions have been known for quite a long time – for those of whose eyes have not yet completely glazed over, these chemicals ought to sound vaguely familiar as the most common of household disinfectants: household laundry bleach is 5.25% sodium hypochlorite solution, tap water is purified with hypochlorous acid and the water we drink from the faucet has about 1 PPM hypochlorous acid, and swimming pools are chlorinated to achieve a concentration of about 1 to 3 PPM. The table below summarizes the concentr! ations of these components in a variety of common liquids, not to mention in a serious of products nearly identical to Microcyn, many of which are also on the market already:

click to enlarge

If one does the math, it appears that Microcyn, as a 0.00625% hypochlorous acid/sodium hypochlorite solution in normal saline, can practically be mixed up at home. One would start with 1 teaspoon laundry bleach (5 ml of a 5.25% sodium hypochlorite solution, or 0.2625 grams sodium hypochlorite), and add that to 4.2 liters of normal saline (same concentration as contact lens solution), for a resulting solution of 0.0625 grams per liter, or 0.00625%. One would of course need to lower the pH of this solution to 7.5 with hydrochloric acid (I’ll admit my acid-base chemistry is too rusty to calculate to precise volume of, say, 20% HCl that would be needed to lower the pH to 7.5, but you get my point). Solutions containing free ! chlorine, such as Dakin’s solution, have been used for many decades to treat wounds. PuriCore sells an electrolysis system that allows healthcare providers to generate dilute hypochlorous acid solutions right in the office.

Of course, Oculus doesn’t call their product “dilute bleach,” even if that is what is it is chemically indistinguishable from. This is because they have chosen a costlier method to manufacture the solution, through the electrolysis of saline solution in the presence of a semi-permeable membrane. This is another old, well-known and well-characterized method for generating chlorine-based solutions (see PuriCore). A paper published by NovaBay scientists (Wand et al., J Burns Wounds 2007; 6: 65-79) describes the three methods for making hypochlorous acid. Here's what was published in this article:

Hypochlorous acid can be synthesized by one of the 3 methods: hydrolysis of chlorine gas (eq 1), electrolysis of salt solution (eqs 2a and 2b), and acidification of hypochlorite (eq 3).

Cl2 + H2O ↔ HOCl + H+ + Cl− (1)

2Cl− + 2e− → Cl2 (2a) Cl2 + H2O ↔ HOCl + H+ + Cl− (2b)

OCl− + H+ ↔ HOCl (3)

The limitations of using equation 1 are the inherent hazards of handling chlorine and the difficulty in manipulation. The disadvantage of the electrolysis method (eq 2) is the difficulty in controlling the target concentration of solution. Since hypochlorite is commercially available, the use of the method in equation 3 is the preferred method and is more convenient, safe, and controllable when compared to the other 2 methods.

Novabay uses the third method, which basically amounts to adding bleach to saline solution and then lowering the pH with hydrochloric acid (sounds familiar, doesn’t it??), whereas Oculus and Puricore use the second method (electrolysis).

Oculus contends that its diluted bleach solution is far more stable than others that have previously been available (although, in its own patent application, US 2006/0235350 A1, Oculus admits that “the manufacturer recommends that once the container of Microcyn is opened, it be used within 30 days”). Clorox Daily Sanitizing spray, containing Sodium Hypochlorite/hypochlorous acid at 95 PPM, is “pH balanced so that it remains both gentle and effective for a full year” according to the product website (http://www.clorox.com/products/faqs.php?prod_id=ahsds#faq3). Di-Dak-Sol, a commercially available diluted Dakin’s solution, has a shelf-life of 14 months (http://www.dakins.net/didaksol.html).

What about the clinical data? Even if this is just dilute bleach in saline solution and anyone can mix this stuff up in their kitchen, maybe it actually works. There are indeed clinical trials/case series of wounds treated with Microcyn. It is very well worth pointing out that uncontrolled, non-randomized trials are basically worthless in studying wound-healing agents because the wound care within the setting of a clinical trial is orders of magnitude better than what patients do themselves outside of a trial setting. Beyond these uncontrolled case series posing as studies of Microcyn, there is one fairly large, prospectively controll! ed study of Microcyn (Dalla Paola et al., Wounds 2006; 18: 262-270), and it is worth reviewing this in some detail.

This was an open label, non-randomized single-center study of Microcyn in 218 patients with grade 2-3 infected foot ulcers. Patients were treated with dressing soaked in povidone-iodine or Microcyn and received systemic antibiotics as well. The article does not identify a primary endpoint, but does list “outcome variables” including complete elimination of bacteria at the time of surgery, healing time, and frequency of wound dehiscence. At baseline, more control patients had ulcers colonized by/infected by multiple bacterial strains (25% versus 36% for Microcyn, p=0.11). At the time of ! surgery, 88% of the Microcyn treated patients compared with 69% of control patients had no detectable bacteria (p=0.0005). Median healing time after surgery was 43 days for Microcyn patients and 55 days for the povidone-iodine group (p < 0.001).

There are a number of major flaws in this study that make it uninterpretable, leaving aside the important issues of this being a single-center, unrandomized open label study. First is the choice of the comparator arm – povidone iodine has long been thought to have a cytotoxic effect and to delay wound healing, and it is dogma among dermatologists and plastic surgeons that povidone iodine has no role in the treatment of chronic wounds. This could account for all or part of the observed benefit in healing time. As far as the wound culture data go, the results reported in the trial are highly suspect. By requiring “no bacterial strai! ns” to be present in the culture prior to surgery, the authors dichotomized the outcome in a way that is clinically meaningless. There is no reason to obtain bacteria-free ulcers; it is well known that ulcers may be contaminated or colonized with no adverse effects on healing or other outcomes. A more useful approach would have bee to perform quantitative cultures and, if one wanted to report a dichotomized outcome, then a cut off of 105 bacterial colonies per gram of tissue would have been a meaningful threshold, as this is commonly viewed as the highest bacterial count that will allow skin grafting. Finally, we have little information on the treatment or disposition of the patients in this study, aside from the surgical treatments used, which did not differ between the two arms. Was systemic a! ntibiotic treatment comparable between arms? How was wound debridement used in each arm, and were enzymatic methods used? Were ulcer sizes and locations comparable between the two arms?

Not to belabor the point, but it is instructive to see what the FDA has had to say about clinical trials for cutaneous ulcer treatments in its guidance document on the topic (http://www.fda.gov/cber/gdlns/ulcburn.pdf). It is quite fair to say that the studies performed to date do not come close to meeting FDA standards (not a surprise, since the company did admit in its S-1 that its studies “were not intended to be rigorously designed or controlled clinical trials and, as such, did not have all of the controls required for clinical trials used to support an NDA submission to the FDA in that they did not include blinding, randomization, predefined clinical endpoints, use of placebo and active control groups or U.S. good clinical practice requirements”), and one seriously wonders how! Microcyn will performed in a regulatory quality trial, compared against a true standard of care. In any case, the FDA guidance document stresses the following attributes of clinical trials assessing wound healing agents:

· Randomization and Stratification. Randomization is particularly important for reducing bias in wound indication trials because standard wound care procedures and baseline wound characteristics generally have a profound effect on outcome.

· Comparator Arms. A comparator arm is recommended for many wound-treatment product trials involving drugs, biologics, devices, and combination products (i.e., drug delivery studies or cellular wound dressings). This is usually a vehicle control arm. The vehicle control should contain the same formulation and excipients as the study product, without the active agent. Such trials should be performed with identical standard-of-care procedures in both the control and investigational product arms.

· Blinding. In general, blinding of subjects and investigators to the assigned treatment reduces bias and should be employed when feasible.

· Wound Assessment and Quantification. For most ulcer types, we encourage the selection of a single target lesion for efficacy determination before subject randomization. . . . The tools to assess clinical trial endpoints should be both prespecified and, for multicenter trials, standardized across clinical sites. . . . Quantitative and qualitative culture of a tissue biopsy can be used at baseline to help determine if the wound is infected or merely colonized, and to guide appropriate antimicrobial therapy. This m! ethod is generally preferred to quantitative and qualitative culture of swab specimens.

· Standard Care. Standard care refers to generally accepted wound care procedures, other than the investigational product, that will be used in the clinical trial. Good standard care procedures in a wound-treatment product trial are a prerequisite for assessing safety and efficacy of a product..

· Efficacy Endpoints. In general, clinical outcomes associated with the use of a wound-treatment product can be broadly grouped into two categories: improved wound healing and improved wound care. . . . Complete wound closure of a chronic, nonhealing wound is one of the most objective and clinically meaningful wound healing endpoints. Complete wound closure is defined as skin re-epithelialization without drainage or dressing requirements confirmed at two consecutive study visits 2 weeks apart. . . . An indi! cation of accelerated wound closure should reflect clinically meaningful reduction in the time to healing using a time-to-event analysis (the event being complete closure). . . . We recognize that products intended for wound management may provide important patient benefit without improving the incidence or timing of wound closure relative to standard care. However, it is important to demonstrate that such products do not significantly impede healing. Thus, wound closure should be evaluated as a safety outcome for all products with a wound care claim. . . . Infection at the wound site impairs healing. Primary efficacy outcomes for topical antimicrobial wound-treatment products can thus be healing, prevention of, or cure of infection. Such antimicrobial products generally should have an established and appropriate spectrum of antimicrobial activity.

It is noteworthy that the Oculus clinical trials to date appear to adhere to almost none of the regulatory standards articulated by the FDA in its guidance document. Again, this is not really a surprise given that the company has admitted as much in its S-1. It does emphasize, however, that there are meaningful risks associated with Oculus undertaking a registration-quality phase III clinical trial of their topical antiseptic solution.

OCLS 1-yr chart:

Note: Some information in this piece was taken from a report on Oculus published by Urchin Capital.

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